Taiwan's Chip Foundries: Zombies No More

By

Bill Alpert

April 14, 2003 12:01 a.m. ET

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IN RECENT MONTHS, INVESTORS HAVE LEFT Taiwan's semiconductor foundries for dead.
Taiwan Semiconductor Manufacturing
and its rival
United Microelectronics
had themselves a world-class business making computer chips for customers like the graphics firms,
Nvidia
and
ATI Technologies.
But production glitches, competition from mainland China and underused production capacity have all conspired to do in the shares of TSM and UMC, along with their New York-listed American depository receipts. The ADRs of foundry leader TSMC trade for 7.40 -- about 2.8 times book value, and far below last year's high of about 19 bucks. United Micro's ADRs have fallen from a high of 10 to a recent 3.26, or about 1.5 times book value. Each firm's ADR represents five shares on the Taiwan exchange, by the way.

But last week, the two foundries reported a strong uptick in March sales. And word out of Taiwan is that their depressed factory utilization rates are snapping back. If TSMC and UMC fill their factories, their shareholders might also become less depressed. Perhaps rising activity at the Taiwan foundries also portends a recovery in sales of computers and cell phones.

TSMC surely had an awful time producing a high-end chip for Nvidia last year. To TSMC's humiliation, Nvidia says it will shift some production to
IBM.
Industry analysts have warned that the Taiwan foundries will have trouble keeping up with technology leaders like IBM, as transistors on chips shrink to dimensions below 100 billionths of a meter. Even UMC Chairman Robert Tsao endorsed this view, when he recently said that his firm wouldn't chase the bleeding edge of technology with heavy capital expenditures.

Increasingly fierce competition from foundries in Shanghai and Singapore convinced UMC to focus on staying cost-competitive. The company continues to make chips at moderate feature sizes of 180 or 150 billionths of a meter -- while making only modest investments in the tiny-transistor technologies that etch lines down to 130 billionths, or even 90 billionths, of a meter. TSMC, for its part, stubbornly insists that it can compete on technology. It is trying to increase production at 130 billionths of a meter -- the scale where it stumbled on the Nvidia chips.

As business slackened last year, TSMC's capacity utilization fell from 85% to 60%. But Wednesday, the company said that revenues for the March month had risen 13% over the year-earlier level, to about $400 million. Sales had "clearly touched bottom" in the quarter, said a company spokesman. UMC, for its part, said monthly sales rose 55% in March from a year earlier, to $200 million. Both firms were upbeat about the coming months.

ABN Ambro analyst Leo Li told clients that utilization at the Taiwan foundries is bouncing back toward 80%. Handset orders from
Nokia
have stoked chip production, as has demand from rising sales of flat panel displays. Graphics chipmakers like ATI are also in the middle of refreshing their offerings, with a new generation of chips.

The foundries have said they'll curb their free-wheeling investment in production equipment -- expenditures that used to eat up most of the cash flow thrown off by their businesses. For the first time ever, therefore, TSMC may show substantial free cash flow this year -- perhaps $850 million worth. That's why UBS Warburg analyst William Dong thinks there's room for TSMC's ADRs to rise from the current $7.40 to $9.50. He's a bit fainter in recommending UMC, but nevertheless thinks the ADRs -- trading recently at 3.26 -- deserve a price of 3.75.

A bigger fan is Michael Ding, president of the International Investment Trust, the Taipei-based firm that manages the R.O.C. Taiwan Fund. His funds own both TSMC and UMC. Ding thinks UMC will swing from a slight loss last year, to profits equivalent to $400 million in 2003, while TSMC could earn better than $1 billion. That's half again better than the consensus forecast. So, there may still be life left in the foundry stocks.

Bigger Than Wi-Fi

Consumer electronics columnists have been cautioning readers who want to rush out and buy a Wi-Fi wireless network. Avoid old-fangled Wi-Fi cards that only poke along at 11 million bits per second (under a protocol known as 802.11b). Insist on the latest Wi-Fi cards, which zip along at 54 million bits per second (under a protocol like the 802.11g).

But wait. Maybe we should all hold out for WiMax. Last week,
Intel,Proxim
and
Fujitsu
joined a group of firms that are already looking beyond WiFi...beyond 802.11...all the way to a protocol they've dubbed 802.16, or WiMax. The WiMax standards group has been at work since December 2001.

Today's Wi-Fi hotspots reach a radius of 300 feet from their base station. WiMax should reach 30 miles. That's more like a hotsprawl.

It's also more of a challenge to other fast Internet services -- particularly the third-generation cellular offerings that are trying to get off the ground. Perhaps that's why one of the early members of the WiMax consortium is Nokia. Also hedging its bets, perhaps, is early joiner
Hughes Electronics,
which wants a piece of any technology that might grab demand from its DirecPC satellite service.

WiMax products won't appear before the end of 2004. Services might then spring up that create a third rival in battle for broadband, which now has two contenders: cable firms and phone firms.

Using the Dark Art

Merrill Lynch took a very sharp pencil Tuesday to its analysis of big computer companies like IBM and
EMC.
Steve Milunovich and his colleague Richard Farmer used the dark art of statistics to study the operating leverage of the enterprise hardware firms -- that is, the earnings bang per buck of additional sales growth. Their study confirmed what the market dimly suspected: IBM has a heck of a business, that's getting better.

Dell Computer
and
Lexmark
have wondrously low fixed costs, but the lowest leverage. Each dollar they add in sales is worth about a dime in operating income. EMC and
Sun
-- struggling to lift their heads above the water level of their overhead costs -- can gain 60 cents and 40 cents, respectively, from each additional sales dollar.

"There's a lot of leverage in these names," says Milunovich. But he cautions that investors may want to hide in the sturdy, low-leverage stocks until it's clear that new product sales are about to lift off at high-leverage businesses like EMC.

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